The Statement and Account Clause and Caperton: Part II

The Court in Caperton v. A.T. Massey Coal Co., Inc. asks not whether the judge is actually, subjectively biased, but whether the average judge in his position is "likely" to be neutral (or whether there is an unconstitutional "potential for bias"). In defining these standards, the Court has asked whether, "'under a realistic appraisal of psychological tendencies and human weakness,'" the interest "'poses such a risk of actual bias or prejudgment that the practice must be forbidden if the guarantee of due process is to be adequately implemented.'"

Part II examines the several important psychological factors that have influenced and continue to influence financial reporting for the federal government. It attempts to explain how and why Congress has put the nation into a situation where financial reporting is so distorted from economic reality. This analysis suggests that there are very significant, and some would say insurmountable barriers, to changing our current circumstance through the legislative process. Therefore, the only resolution is through the judiciary. The framework for Part II's analysis is inspired by a talk given by Charlie Munger, The Psychology of Human Misjudgment [PDF]. Munger is the long time business partner of Warren Buffett.

Congress and the executive branch have created a set of circumstances that takes advantage of multiple psychological tendencies that affect all parties interested in the electoral process. These psychological factors, which are generally well documented in psychology literature, ensure that political accountability is significantly diminished and that the competitiveness of the electoral process is materially degraded. It is hard not to view the creation and alignment of these psychological factors as "corruption." Munger calls the alignment of multiple psychological tendencies all working in the same direction as the "Lollapalooza Tendency."

Let us begin with "incentives." B.F. Skinner, the famous Harvard psychology professor, proved that incentives could cause significant behavioral change. His experiments proved that bad behavior is intensely habit-forming when it is rewarded. When choosing between different outcomes, elected representatives can be expected to consider which course of action is most likely to contribute to their own reelection and which course of action is most consistent with the ideological commitments and policy goals of their constituents.

As Alexander Hamilton famously wrote when explaining the benefits garnered by a public official making decisions with an eye toward reelection, "the desire of reward is one of the strongest incentives of human conduct ... [and] the best security for the fidelity of mankind is to make their interest coincide with their duty." In Pennsylvania, elected trial court judges sentence [PDF] criminal defendants to longer prison sentences as an impending election gets closer. In Chicago, criminal defendants convicted of murder are 15 percent; more likely [PDF] to receive the death penalty if their trial occurs during an election year for the presiding judge. Further, across the nation, in cases between one in-state party and one out-of-state party [PDF], elected state court judges are more likely to decide cases in favor of the in-state litigant than appointed judges.

Since entitlement programs were first created, Democrats and Republicans have had a significant incentive to be less than forthright with respect to their cost. They get elected by promising that benefits are guaranteed and that additional entitlements are possible. However, they do not permit any expense or liability associated with promises that must be paid in the future included in any financial statement to which they could be held accountable. Doing so would reveal massive deficits far exceeding our current budget deficit that would be impossible to justify and would likely lead to many elected officials losing their "jobs."

Punishments strongly influence behavior, which is why politicians are very familiar with the "Persian Messenger Syndrome." In ancient times, Persians killed some messengers whose sole transgression was that they brought home truthful bad news. This is why no politician at any level wants to take the lead on informing the electorate as to the true state of the nation's finances. George Washington hanged deserters [PDF] forty feet high as an example to others. Unfortunately, over the years there have never been any negative repercussions for any of the politicians responsible for the nation's deficient financial reporting.

The population's tendency to reciprocate favors and disfavors is well known to politicians. They know that their constituents want to hear about better benefits and nothing about increased costs. Politicians fully understand how the world works. You enact legislation that provides better benefits for me (or lowers taxes), and I will vote for you. You take away my benefits (or raise my taxes), and I will vote you out of office. This reciprocation tendency has stopped wars for considerable periods of time. It is also the reason why there are periods when no prisoners are taken. It is why purchasing agents at most large commercial establishments are not allowed to take anything from a vendor. The reciprocation tendency, coupled with other tendencies discussed below, ensures that a political candidate for office challenging an incumbent cannot use the fraudulent financial reporting issue to win over the electorate. It is a losing political strategy in all cases. One may inform voters but the candidate will never get elected.

Successful politicians are very good at voter psychology and pursue strategies to take advantage of the "Liking/Loving Tendency" and the "Disliking/Hating Tendency." It will surprise no one that politicians prefer being liked by their constituents. Hence, they exhibit behavior to maintain this state of affection which involves ignoring the facts as they relate to the nation's financial condition and making sure that the true state of the nation's finances is not made public. Similarly, the electorate likes getting additional benefits especially if it does not cost them anything.

"Politics is the art of marshalling hatreds." One of the most important factors that has led to a significantly distorted electoral process is that the electorate does not want to know the truth about the poor condition of the nation's finances. Everyone likes a "free lunch," but as economics texts instruct, there are no "free lunches." Not surprisingly, the people do not want to know any bad facts associated with the cost of their benefits. Politicians have used, and continue to use, people's dislike for any negative facts associated with any of the nation's social insurance programs to their advantage, particularly in negative advertising. The electorate hates being told bad news, especially if it entails a possible bill for them.

The "Social-Proof Tendency" is the tendency for a person to think and act as others around him are thinking and acting. It tends to be triggered in periods of stress. Given that no one in Congress or the executive branch is pointing out the fact that the government's financial reports fail to reflect economic reality is social proof that the statements must be correct. If a politician dared to raise the issue, his reception among his colleagues and the electorate would be similar to the reception that the corrupt New York police division gave to Frank Serpico. The corruption in the New York police was driven by social proof plus incentives.

It is highly likely that the dysfunctional behavior surrounding financial reporting by Congress and the executive branch will continue as significant stress causes dysfunction (the "Stress Influence Tendency"). The noted researcher, Ivan Pavlov realized that extreme stress created unanticipated extreme changes in behavior. During the great Leningrad Flood of the 1920s, Pavlov had many dogs in cages. As the waters rose many dogs reached a point where they had almost no airspace at the top of their cage they were subjected to maximum stress. This changed the behavior of many dogs. To a certain extent this explains some of the dysfunctional behaviors that our politicians exhibited in dealing with the fiscal cliff crisis, and it is a precursor of more dysfunctional behavior to come with the budget deficit and debt ceiling debates.

Politicians know that rational or reasonable explanations increase compliance with orders/requests. The "Reason-Respecting Tendency" is the reason that there is an enormous bureaucracy associated with the president's budget. This bureaucracy ensures that there will always be reasons supporting the figures presented.

When confronted with the nation's fiscal distress, most politicians talk about our ability to deal with the issue by growing our economy. This displays society's excessive optimism (the "Overoptimism Tendency"). The right approach is to focus on the hard numbers, something that Congress and the executive branch are loath to do.

Politicians know that if reality is too painful to bear, they should distort the facts until they become bearable. This "psychological denial" could explain at least one of the arguments for maintaining the current accounting for social insurance. As the Federal Accounting Standards Advisory Board opined [PDF], "[r]ecognition of future social insurance benefits on the financial statements would diminish significantly the relative size and importance of other expenses and liabilities shown on the financial statements ...."

When steps are taken towards disaster, but each of these steps are small and barely discernible, a person's "Contrast-Misreaction Tendency" will often let the person go too far. The reason is that each step is such a small contrast from the person's current position. As Ben Franklin once said, "[a] small leak will sink a great ship." In the case of financial reporting it is so because, over the last 75 years, politicians and the electorate have intentionally hidden or ignored the leak.

The "Authority-Misinfluence Tendency" explains how authority figures (like the executive branch) can lead ordinary people into gross misbehavior. Stanley Milgram conducted experiments to show how far authority figures could lead people into such misbehavior. The framers of the Constitution distrusted the executive branch. Distrust of the executive branch is what led the framers to put financial responsibility solely in Congress's hands.

One of the truths about the electorate is that, on the whole, they exhibit the "Excessive Self-Regard Tendency" (in other words, the "Endowment Effect"). Once owned, or thought to be owned, social insurance benefits become worth more to a citizen than if they were offered for sale to the person and the person did not own them. The "Excessive Self-Regard Tendency" is illustrated by a Leo Tolstoy passage: "According to Tolstoy, the worst criminals do not appraise themselves as all that bad. They come to believe either (1) that they did not commit their crimes or (2) that, considering the pressures and disadvantages of their lives, it is understandable and forgivable that they behaved as they did and became what they became. " One could easily substitute our politicians into this story in place of criminals.

A final truth about the electorate is that loss seems to hurt much more than gain adds to a person's pleasure (the "Deprival-Supereaction Tendency"). Therefore, it is not surprising that the electorate will react with almost irrational intensity to any loss or threatened loss, however small, of social insurance benefits.

Joseph Marren is the President and Chief Executive Officer of KStone Partners and an SEC-registered investment advisor that specializes in managing hedge funds. Previously, he was Head of Business Development in the mergers and acquisitions departments at several firms including Sagent Advisors, Citigroup, Credit-Suisse and DLJ. He is the author of two books on mergers and acquisitions, taught at New York University Stern School of Business and is a graduate of Fordham University School of Law.